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Advice from a Real Entrepreneur on Selling a Business

Takeaway:There are lots of articles from advisors on selling a business, but business owners want to hear from their peers on what to look out for. In this interview, Mike Michalowicz, author and entrepreneur, provides insight on navigating through the process.

In this session you will learn about:

What it was like to sell two companies;

Lessons learned in the process, including being part of the negotiation;

The culture clash of selling his company to a Fortune 500 company;

Mike's biggest mistake, which he said was really dumb; and

Why he said you should always have multiple bidders.

About the Guest

Mike Michalowicz started his first business at the age of 24, moving his young family to the only safe place he could afford - a retirement building.

With no experience, no contacts and no savings, he systematically bootstrapped a multi-million dollar business. Then he did it again. And again.

Listen Here:

Read the Full Transcript Here:

Noah: Well, I’m so glad to have with us today Mike Michalowicz. He’s the entrepreneur behind three multi-million dollar companies and the author of The Pumpkin Plan and the business cult classic, The Toilet Paper Entrepreneur, with a popular and quirky website, which is www.mikemichalowicz.com. He’s a globally recognized entrepreneurial advocate. Mike’s a former small business columnist for The Wall Street Journal and now hosts the business makeover segment on MSNBC’s "Your Business." Mike, I’m so glad to have you with us today. Let’s jump right into it and maybe tell our listeners about Olmec Systems, the first business you created and sold.

Mike: Sure. It’s so good to reconnect me and you. My first business, Olmec Systems, was computer networking. It was kind of a business I fell into. I never planned on being an entrepreneur but after working for another computer company one day had this kind of fit for freedom. Just, I can’t take it here anymore. I’m going to do my own thing. I started a computer networking company. Actually, I sold it to private equity, and it still runs today. It’s one of the premier players and it’s vertical.

Noah: That’s great. When you started that business we’re you thinking, "I guess this is my future. I’m going to do this forever," or did you know what you were doing when you got started?

Mike: Yeah, I had no idea. I never thought I’d start a business until the morning I started the business. I kind of just fell into it. It was interesting, the transitional phase you go through when I thought about starting it, which was literally about a day of thought, excitement, exuberance, "Oh, my God. I’m going to be rich. This is the secret path to success." Then when I started and no one called and I didn’t even know how to make someone call me, then fear came to me.

I found that ironically for entrepreneurship, through all of my experiences now, fear is one of the key elements you must use. It’s a great motivator to get you up in the morning and get you going. The problem I started falling into is fear becomes a trap ultimately if you live in fear because while it gets you motivated every day, it starts causing stress, disbelief, you lose confidence of any degree, and you stay kind of stuck in this circular trap. So no plans on going into it, but when I did I started discovering this is my passion. I love entrepreneurship.

Noah: So then how did you decide it was time to sell Olmec? What prompted you to seek out a private equity investor?

Mike: What I did, actually, I had partners. I started up with a partner, and I had another partner that we brought in as we were moving along. There was a certain point. We were making a few million in revenue, and it was supporting a lifestyle. I came to realize a company that makes a couple million, to some people that sounds nice, but when you have three equity partners all pulling a salary, maybe you’re not running it that efficiently. We were doing, in retrospect, a pretty crappy job at running it efficiently. My partners had achieved a lifestyle they were comfortable with.

I’ll never forget. Both of those guys came to me and said, "I could live like this forever." I was like, "Holy crap. We’ve got to get to 50 million, 100 million. We’ve got to dominate the world." There was the incongruency of vision, and this was a little lesson I learned with partners. When partners start together, as long as business is moving along, everyone is on the same path. At a certain point as the business grows, there is a divergence in the vision. So there wasn’t clarity from the beginning. We didn’t think about it.

We both wanted a wildly successful business. That was the "vision." We had this divergence of where we wanted to take it. I recognized it would be insurmountable. So I said I wanted to leave. They said they wanted to stay. We negotiated a private equity investment. It was a nice, comfortable exit for me, and I stepped aside to do the next business.

Noah: In that transition, what were some of the things that you take away that maybe if going back, if you could do it all over again, you would have done some things different? What would they be?

Mike: Well, clarity and vision is a big deal, to really have clarity on what I wanted out of business in regards to monetary performance, what the company would mean to me almost on an emotional level, and how would I be representative of the company, and discuss that with your partners. I never really thought about that, to really have absolute clarity of what we want. The other thing is there were no trigger points. There were no metrics or measurements in place. I wish I did that. I wish what myself and what my two other partners wanted with absolute clarity but then also some ability to adjust the company if we’re not hitting what we agreed to.

For example, one of the partners there - I definitely will not say names. You could find it in the newspapers, though, because there was talk about this guy. One of my partners there, I consider his work ethic, let’s just say, different than mine and the other partner. I felt that the effort I was putting in to push the company along was disproportionately more than this other partner. Yet we did from the beginning this stupid - you know, first it was me and this other guy 50/50. We brought another partner, and we started splitting stuff equally, which is a grand, grand mistake.

I even write about this. I wrote about this in my next book that no partnership when it comes to two partners should ever be 50/50. We should agree what the performance is. Then when the business starts, each of us for a thank you of having our back for starting gets 5% each. The remaining 90% stays within the company and is divided up over time based upon the performance metrics we agreed to. Who is bringing in the sales? Who is doing the work and getting the service or the product delivered? Who is growing the team? Who is putting in the most hours?

Those components, if I had to divide it up based it on performance, I feel my equity stake would’ve been much greater. No matter what, I think it would’ve been a fair distribution. Even if it were less, it would be based upon action or performance. I wish I did that, in retrospect.

Noah: So when you started the next company, were you wise enough to change that, or you didn’t come to those conclusions until later in life?

Mike: Yeah, it came a little bit later in life. Every company I have had since then or business project even, I’ve done it based upon performance metrics, and it has served me well. My second company, no. I sold my first company. In the immediate frustration, I was like, "Oh, I’m just glad to be rid of these guys," and I knew at that time I needed to have clarity. So I started with another guy. His name is Paul Lewis. We got together and we started a company called PG Lewis. It’s a little shell company he had, and we just kept the name. Michalowicz is much harder to say than Lewis.

We started it, and this guy, what I liked was his vision was congruent with mine. We really wanted to grow as leading authority in an industry. We didn’t have the equity plan in place until later in life and wish I had known it then, but at least we had a common vision, and that served us both very well.

Noah: When you started, did you guys have a built to sell model, or was this a built to build?

Mike: Yeah, built to sell. We both agreed going in. He used the words pump and dump because that really has this artificial tone to it, but those are the words we used. We said we wanted to build a pump and dump company. We wanted to have an exit within five years. We did the full cycle of two and a half. It was acquired by a Fortune 500. That was a vision from day one. The business immediately started taking root with that mentality, built to sell.

Noah: How did that come about earlier than planned and maybe just describe the process of, you know, "We’re ready. We’re ready to find a buyer. The buyer is knocking on the door. We’re ready to talk."

Mike: Yeah. It’s funny. I really learned a lot about myself in retrospect. When I look back at the company now many years later, I finally have come to appreciate how much luck has to do with everything. When we built and sold the company, I was like, "Wow, man. Do I know what I’m doing? A good partner. He knows what he’s doing. We really know what we’re doing." In retrospect, it was luck.

Just to give the back-story, the company was in computer forensics. Well, computer forensics we started back in 2003. Midway through 2005, we’re in the sale. Right before 2006, the company was sold. So two and a half years. Bootstrapped the company. We were in our second year on a run for seven and a half million when the acquisition process began.

What I discovered was that we had hit the right time in computer forensics. It was a public sector thing long before it was for the private sector. There were definitely companies doing it, but it wasn’t established. Demand was way outstripping supply. The second thing is the demand was growing for individual companies. Where our typical project may have been $10,000 of forensics work, it was skyrocketing to hundreds of thousands for many companies. One of the biggest cases in US history, even to date, was Enron. We got the Enron trial. There were other forensic companies in there. We were one of the lead investigators, defense side investigators. Now you’re talking about significant revenue, hundreds of thousands a day all of a sudden we were making by getting that case.

In retrospect, a lot of it was luck. I didn’t cause Enron to happen. I was at the right place at the right time, and Enron called us. That was a major component to our success. The other thing is the recognition of systemization from day one. I had known from my first company that it’s a mistake to hire experienced professionals and have them inserted in your company as much as build a system where anyone can come in and execute at the level of an experienced professional.

As we were developing the forensics practice, I spent - and my partner too - an inordinate amount of time of doing the process myself, documenting it, and figuring out how to make it replicable. Then we started bringing on these "rookies," people that had the right attitude, energy, and intelligence, but didn’t necessarily know how to do the process from experience. Well, they come on at a much lower cost point, one quarter of the cost of the experienced pros in the industry, and with the right system were able to deliver at the same level if not beyond some of the pros.

We were getting labor at one quarter of the cost and delivering at the same level, and I would argue in many cases higher because we had such a consistency in our process. That, coupled with good timing and good fortune - my partner Paul and I used to like to say we hit the wave and just surfed that thing all the way to the shore, up the shoreline, on the beach, and into the house.

Noah: So what happened? Someone came knocking? How did the process go for you guys?

Mike: Yeah, we were approached. This is where we made a mistake. We were approached by a Fortune 500, Robert Half International. They saw one of our team members at a speaking conference, and that was actually a strategy too. We figured out a way to stand out at conferences, which was really simple and really unique and drew a lot of interest and traffic in our business. Well, it attracted Robert Half International and they said, "Wow, you have something we can just plug into our company, something we know we have to develop. We just want to plug you in." They want to punch their bottom line. They want to take on another 10 million and show it on their P&L for their stock to go up.

Secondly, instead of developing it and costing millions, spend it and instantly have a thing you can plug into your company. Thirdly, potentially one of the strategies of these large companies is you wipe out a potential threat. You just take them over. For them, it was a strategic acquisition. For us, it was a mistake because it caught us off guard. It caught us way earlier than we anticipated. So we courted it, but the grand mistake we made was we didn’t know if we were going to go out for bidding. We just courted with one company and went to business with them instead of inviting other people to go into the bidding for us.

Noah: Do you feel like you got a price that was actually above your expectations, but in spite of that, there was probably more on the table?

Mike: No, I think we didn’t get above our expectations. We did well. In retrospect, I’m very happy. I’m disappointed in we didn’t finish out our plan, so we could’ve gotten a lot more. From a purely monetary standpoint, we could’ve gotten a lot more. The other component is when you get bigger now there are a lot of guys asking you to dance. You don’t only have one suitor. You have a lot of suitors. Then they get more aggressive. The fact that Robert Half knew we weren’t out bidding, they could stretch it out a lot longer. To do diligence, they could leverage more and say, "You know, we didn’t like this. We didn’t like that." Where if you have bidders, you can say, "Well, you don’t like it, but the other guy does. Sorry," and you have some leverage. We defeated ourselves because we didn’t have leverage by having just one bidder.

Noah: Who was involved in that conversation around selling? Did you have a law firm advising you? Did you have an accounting firm advising you?

Mike: Yes and yes. We didn’t have a broker or an investment banker. We handled negotiations directly. This was another grand mistake I made. My partner and I sat down real quick. He sold another business before to a public entity. I had only sold one before privately. It’s a little bit of a different game. He had more expertise in it. He has a penchant for negotiations so I said, "You know what? You do that. I have a penchant for running the business and building the culture. I’m going to stay back there." One tragic mistake - and we didn’t fall into this tragic - but one grand mistake that companies make is when you have a suitor and you hear that beautiful number - now the term is the cash event, right - the biggest cash event you have in a business, typically, is selling the company.

Yeah, you make a nice salary, you have nice distributions, but when you sell the company that is a fat, fat check that’s coming your way. Well, the trap that many entrepreneurs fall into is you see that fat check is coming in, and you emotionally start spending the money before you have it. We knew this and said, "I’m is not going to worry about that. My partner is going to focus on negotiations. I’m going to make sure that in the business there are no cracks in the foundation because we’re all looking at the money. I’m going to position it like we’re not selling at all and keep this business growing." That was a smart move we made.

Noah: Yeah. What would you say after the transaction took place? What are some of the things that you learned from the experience that you think other business owners might be happy to hear about and maybe avoid the same mistakes?

Mike: First of all, I would never negotiate a deal yourself. If you’re a business owner, keep running that business. Put the blinders on. Bring in a professional accountant. Bring in a professional investment banker, somebody that negotiates deals. Sometimes accountants do that, but I would bring in someone who knows what they’re doing, specifically in negotiations, and can invite in other bidders. Bring in an attorney who knows what they’re doing. We had two of those three. We should’ve had all three. Then just keep growing the business.

The other lesson is get bidders involved. I mean this really amplifies your return. You can get a lot more money out of your company when there are multiple people interested in it. This is the one thing I did right: Never spend the money before it’s in your pocket. That’s when the cracks in the foundation of your company start showing up, and it can throw you off course. Then you’ll be lucky if you can sell the company in the worst case. In the best case, you’re going to get way less money than you could have because the cracks in the foundation are starting to show.

Noah: So if we have an owner that’s listening and they’re hearing about some of your experience, what would your advice be just in a general sense on how to start preparing for an exit, whether that’s going to be an internal transfer, a private equity firm, or to a public company, or a strategic acquirer? What are some of the basic things they should be doing?

Mike: The basic thing is to remove yourself from the business. It’s funny. I’m now developing a consulting arm that’s helping companies grow, not necessarily with the objective of selling, but that’s one of it. One of the things that we instill with the people we consult is we call it the four-week vacation. We’ve got to get these entrepreneurs that own the businesses going on a four-week vacation minus the cell, minus the laptop, and really a vacation because we need the business running independently of them. The biggest fear a suitor has is that if the entrepreneur leaves, is this business going to collapse.

It’s shocking. There are companies out there doing 5 million, 10 million, 100 million where the entrepreneur still is a linchpin to the business. It’s still depending on one guy. You have to build systems that replace you. You know you’ve got it right when you’re away for four weeks and your business has not only sustained, it has actually grown. If it can grow in your absence, now you have something where you are dispensable. Ironically, that’s what you want because now an acquirer can take the business.

Noah: That’s great advice. What about discussing an exit strategy with an executive team? Maybe you could talk from experience, either through your deals or the experience of other owners that you’ve met. What would you say is the best way to begin that discussion?

Mike: Yeah, the trap of the owner - or myself - was here I’m the king of the mountain, so I feel I’m worth more than anyone from the outside thinks I’m worth. I get why it works and they don’t. The advantage of having this executive team around you - and you do this before. You don’t wait until you have somebody to buy your company, and now you get everyone together. You assemble them well, well in advance, maybe even when you’re starting the company. If you didn’t assemble them then, you better assemble them now. Here you have now an outside vantage point. They can see the forest. You can only see the trees. Emotion is removed.

When it comes to positioning your company for sale, you want to remove the emotion. You want the other side to have emotional thirst to buy you, and you do that by getting bidders, but you want to remove the emotion from your business and make it a very calculated process. That’s what your exit team does for you. They’re not in your business, so they’re not living the day to day. They can think on a much more calculated basis. They can leverage their contacts and their experience definitely to your advantage. I would spend every penny I have on getting a good executive team because that’s going to come back in dollars for the pennies I’ve spent.

Noah: Great. Before we’ve got to wrap up, Mike, maybe you want to share a story about a real hard decision that you had to make and you were concerned about the consequences of going left to right and what you did and what you’ve learned in hindsight.

Mike: It ties into acquisitions, but it’s actually the aftermath, and it really was a heart wrenching process for me. It threw me into a dark period. It’s something you and I were talking about offline in part. What it was the culture clash. Neither I nor this Fortune 500 that had acquired hundreds of firms before us had prepared for the cultural conflict. So here’s this little 30-person company that my partner and I had grown. We’re on a run for seven and a half million and growing. We get acquired, and now we get inserted into a department that does 200 million, a single department in New York City that does 200 million, and we’re plugged in there.

So we are less than three percent of the revenue. They are the big slow spinning gear, and we’re this hyper fast small spinning gear. You try to match these up, and the culture is shredded. It wasn’t theirs who got shredded. It was ours that got shredded apart. Within a year, we had lost almost every employee. I left. I actually got terminated for lack of performance. I could not handle this new culture that was like this Goliath, I consider a kind of brown nosing gamesmanship.

The interesting thing was our company was designed to be such a rapidly responsive company that when we had a client call in we were typically dispatching within 30 minutes of a call on site for local, regional work within two hours doing the work. Now this new Behemoth, the turnaround, the exact same request took two or three weeks. We started losing client after client because they couldn’t achieve the speed that we needed to do, and we couldn’t understand how they could act the way they did. Huge culture clash. Lots of personnel lost. Almost every employee left within a year. It was a disaster after we were acquired. I regret, and I blame it on both sides not understanding the culture and the great differences that existed.

Noah: Mike, why don’t you just quickly tell our audience the types of things you’re doing now to help business owners and how they can get in touch with you.

Mike: Yeah. Ironically, after building these two companies and selling them, I started a third company. That one failed. I started a fourth company, and that got into millions of revenue, and it’s continuing to grow. I’m doing a few things, but my core competency is I investigate all businesses that are out there. I love to deep dive into the ones that succeed and fail and learn what happens, and I’m writing books. That’s my core passion. I’ve become an author. I’ve written two books. The Toilet Paper Entrepreneur is my first, The Pumpkin Plan. I’m working on my third right now. It should be out in about a year. You can check out all my findings. Go to www.mikemichalowicz.com. Just give your best attempt at spelling that. Google will find me. If you want to check out the books, go to Amazon for The Toilet Paper Entrepreneur or The Pumpkin Plan. You’ll find them there.

Noah: Great. We’ll have all those listed on our website www.divestopedia.com. Mike Michalowicz, thanks so much for joining us today, and thanks to all of our listeners.

Noah Rosenfarb, CPA/ABV/PFS has devoted his career to advising business owners on all things related to money. He is a Personal CFO and Holistic Wealth Coach at Freedom Business Advisors, which provides middle market business owners guidance on how to successfully transition out of the management and or ownership of their company. Mr. Rosenfarb is the author of EXIT: Healthy, Wealthy and Wise and co-hosts the Divestopedia podcast where he is both a contributor and Advisory Board member.